How Do Professional Investors Measure Risk in Stocks?

When it comes to investing, be it the stock market or any other asset class, risk and returns are highly correlated. Any investment opportunity with a higher return potential generally comes with higher risk too. In other words, before you invest in stocks, it is first essential to measure the investment risk thoroughly.While every investor and his/her risk management strategy is different, there are popular methods commonly used by professional investors. Take a look at how experts measure risk in stocks-

To begin risk assessment, first, understand the types of investment risks. All the different types of risks associated with stock investing can be divided into two categories-Qualitative and Quantitative. You should individually assess both categories to reach a fruitful conclusion.

The qualitative risks are risks associated with the investor. For instance, the time horizon for which you want to invest, financial goals, risk tolerance capacity, etc., are all different types of qualitative risks. You can assess the qualitative risks based on the sector/stock you are considering and their historical performance.

The quantitative stock market risk is a statistical or analytical measure for assessing a stock or sector's risk profile. This branch of risk assessment is divided into five different measures, and every measure offers a unique overview of risk that any particular security carries. The five risk measures are as follows-

• Alpha- It measures risk in comparison to a particular index to which a stock belongs to. For instance, Nifty 50 would be considered the benchmark for any stock that makes up this index.
• Beta- It helps measure the systemic risk or volatility of the selected stock compared to its index. If the beta is 1, it means that the stock's volatility is in line with its index. A score of lower than 1 indicates that the stock is less volatile than the index.
• Standard Deviation- It measures data dispersion from the expected value. In simple words, standard deviation measures how the short-term gains from stock have moved compared to its long-term average.
• Sharpe Ratio- It measures stock performance adjusted by associated risks. Sharpe Ratio is commonly used to compare mutual fund schemes, wherein funds with a higher Sharpe Ratio are considered worthwhile.
• R-Squared- It measures the percentage performance of security affected by the movements of its benchmark.

New investors should first focus on taking measures to reduce risk and then focus on maximizing profitability. A blend of qualitative and quantitative risk assessment is proven to help investors make smarter investment decisions. Try to learn more about these risk categories to align the investment risk with your expectations.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.